Accounting Economics Marginal Analysis

Define marginal revenue.

Explain its relationship with total revenue.

Marginal Revenue (MR) is the revenue that is linked to one more additional unit of production. The demand for the product will determine whether it will be higher or lower or even the same as the previous unit of production revenue. MR can be defined therefore as the addition realized revenue to the Total Revenue (TR) by a unit increment in the sales volume of a firm in the market (Economics Concepts, 2011).

For instance if a lime factory sells 100 liters of lime at $4 per liter, the total revenue of the factory would be $400. Incase the factory increases the sales volume from 100 liters to 101 liters, then the total revenue of the factory increases to $404. The increase by $4 in the total revenue by one unit increase in rate of sales per period of time is the MR.

Formula; MR = ?TR

Q

Where

MR is Marginal Revenue

TR is Total Revenue

Q is quantity

B. Define marginal cost.

1. Explain its relationship with total cost.

Marginal cost is the cost that a manufacturer incurs in producing one extra unit of an item. It is the cost of the additional inputs that are required to produce the output. It can also be referred to as the derivative of total production costs with respect to the output levels (Econ Model, 2011). As the production increases, the average total cost curve will decline as the fixed costs will be spread across the large number of goods being produced. This will however change according to the law of diminishing returns and the curve of the average total cost will start climbing.

The total cost can be found by combining variable cost and fixed cost combined

TC = VC+FC

When the total cost is divided by the quantity of goods produced then we get the average total cost.

ATC = TC/Q

Therefore the marginal cost will be the result of the change in total cost divided by the change in quantity

MC=?TC

Q

The total cost and the marginal costs are related in that if the total cost curve has a positive slope (upward sloping), then the marginal cost is also positive. More so, if the total cost curve has a positive slope that becomes increasingly steeper, then the marginal cost is positive and rising.

C. Define profit.

1. Explain the concept of profit maximization.

Profit can be defined as the sum total of the amount remaining after the costs whether they are direct or indirect costs, have been deducted from the income of a particular business venture. It can be in a summery said to be the excess of selling good's price over their cost (Merriam Webster, 2011).

Profit maximization can be found by equating marginal revenue with the marginal costs. Regardless of the market structure, the fact that marginal revenue equals marginal cost is normally used to indicate the profit maximizing levels of output of businesses (John Wiley, 2011). This process that businesses undergo to determine the bets price levels and best output is what is referred to as price maximization. The firms will more often than not adjust influential factors like sale prices, production costs and output levels in a bid to maximize the profits as projected. Most companies use either Marginal Cost-Marginal revenue method or Total cost-Total revenue methods to achieve their profit maximization. Profit maximization can be a good thing for the business or company but can turn out to be a bad idea to the customers when the company starts to use substandard items for the sake of profit maximization, or even decides to raise prices altogether.

D. Explain how a profit-maximizing firm determines its optimal level of output, using marginal revenue and marginal cost as criteria.

The optimal level of output is realized by a firm when they achieve the highest possible profit levels in that firm. The marginal revenue vs. The marginal cost is one of the prominent ways to determine the levels of profit maximization. The maximum profits can be said to have been realized when the marginal cost is equal to the marginal revenue. This is where the two intersect in the graph and optimal levels of production are assumed to have been obtained. At this level any increase in the production of the goods will lead to additional costs than revenue hence reduce the profits and on the other hand, any decrease in production will subtract more from the revenue of the firm than reduce the cost leading to a consequent decline in profits (Amos Web, 2011).

The profit maximization can also be determined by using the Marginal Cost Marginal Revenue method. In this...

In this case if the marginal revenue is higher than the marginal cost then the marginal profit is said to be positive. On the other hand if the marginal revenue is found to be less than the marginal cost then it is noted that the marginal profit is negative. The marginal profit can as well be zero, in a situation where the marginal cost is same as the marginal revenue. It is apparent therefore that the total profit will increase when the marginal profit is positive and in the same manner decrease when the marginal profit is negative, therefore total profit must be maximum in a situation where the marginal profit is at zero (Anastacia Zoldak, 2011). In order to achieve this profit maximization strategy, the firm must increase their sales as well as minimize their costs.
E. Explain what action a profit-maximizing firm takes if marginal revenue is greater than marginal cost.

In a situation where the MR is greater than the MC, then a profit maximizing firm should increase the levels of production since the ideal production levels or output levels are determined by letting the marginal cost to be equal to the marginal revenue, it is only when this equality is achieved that the firm can boast of having achieved the profit-maximization limits.

F. Explain what action a profit-maximizing firm takes if marginal revenue is less than marginal cost.

When the MR is less than the MC, then a profit-maximizing firm needs to reduce the outputs and the reduction of production will lead to lesser costs for the firm. This should continue until the MR and the MC are equal so as to achieve the optimum output levels and maximum profits.

Task Two

Supply and Demand

A. Define the following three terms:

1. Elasticity of demand

2. Cross-price elasticity (include substitutes and complements)

3. Income elasticity (include normal and inferior goods)

Elasticity of demand

This indicates how much quantity demanded changes when the prices of goods or services change. It measures the responsiveness of the quantity of demand to the price changes in the market (Samuel L.B., 2006). The change in price may at times cause significant changes in demand, for instance many people would seek for alternative holiday spots locally with the increased airfares, while the increase in the price of coffee may not affect much the demand among those who see it as an essential commodity. It is therefore said that the more the quantity changes due to prices the more elastic the demand is. The elasticity of demand is very significant for any organization since it helps to foretell the effects of change in price to the revenue of the firm (Business Book Mall, 2011).

For instance if

Old Price =9

New Price =10

Quantity Demand (OLD) =150

Quantity Demand (NEW) =110

To calculate the price elasticity, we need to know the % change in quantity demand and then the % change in price.

%?QD=QD (New)-QD (Old)

QD (Old)

With our numerical above we get:

%?QD =[110-150] / 150 = (-40/150) = -0.2667

Hence the %?QD = -0.2667 (this can be left in decimal terms, however in percentage terms this would be -26.67%).

%?P=P (NEW) - P (OLD)] / P (OLD)

With our numerical above;

%?P =[10-9] / 9 = (1/9) = 0.1111

From the above two values found we can calculate the price elasticity of demand.

PEoD = %?QD

%?P

PEoD = (-0.2667)/(0.1111) = -2.4005

When analyzing price elasticity the concern is on their absolute value, so the negative value is ignored. Hence the price elasticity of demand, when the price increases from $9 to $10 is 2.4005 in our example above. The following should be noted of the price elasticity of demand values that may be found:

If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)

If PEoD = 1 then Demand is Unit Elastic

If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

Cross-price elasticity (include substitutes and complements)

This is the percentage change in the quantity demand of one product occasioned by a given percentage change in the price of a related product. With the variation in the prices, the demand of a particular item does not solely rely on its price but that of other products as well that may be a substitute or a complement to it. Cross-price elasticity is used to classify and group items that may compete against each other. For instance if the increase in the…